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Why Gresham’s Law Means the Death of Bitcoin.

One thing the bitcoin enthusiasts have forgotten about is Gresham’s Law. For those who need reminding, it basically states that as long as the dollar is legal tender, meaning you are forced to accept it in payments, then people will spend their dollars and hoard whatever money they perceive as superior. This will go on until the better money disappears from circulation.

Which is exactly what is happening now to bitcoins. The tiny amount of people who know bitcoins exist overwhelmingly do not spend them at all. They are so positive bitcoin is superior to dollars, [especially since bitcoins will go up in price forever, they think] that the moment they get their hands on a bitcoin, they hoard it. 97% of all bitcoins have not ever been used to buy anything.

So that bitcoin has no chance whatsoever. If the bitcoiners bang the drums about how great bitcoin is, then people will hoard it, but never use it as money. If they try the reverse, and tell everyone what garbage bitcoin is, then, since no legal tender laws protect bitcoin, nobody will bother with it in the first place.

What about the small amount of people today who do buy things in bitcoin? They have not thought things through. They have not figured out that whether bitcoin is better than their local currency, or whether it is worse, they are better off not using it to buy things. If you think it’s better, hoard it. If you think it is worse, don’t touch it in the first place.

The bitcoin crowd hopes that bitcoin use will expand in an ever increasing circle. A friend will bring in a friend, or something. They talk about network effects, and kickstarts.

But we have shown that it is just plain shooting oneself in the foot to buy things with bitcoin, whether you think it better or worse than dollars. Is there a network effect for poor thinking? Can stupidity be kickstarted? You know what Abe Lincoln said, and the bitcoin mania proves yet again. You can fool some naive people all the time, and everyone, maybe, in the short term, but long term, there is no network effect for these things.

So what does this mean for the ultimate future of bitcoin? Very simple. Some people will not touch it. The hoarders will hoard. But then what?

When Gresham’s Law took effect in the past, the better money that people hoarded was gold or silver. It had intrinsic value. Gold and silver do not depend on being money for their very existence.

But bitcoin is different. Say you have a huge hoard of bitcoins. You don’t intend to spend it, ever. So of what use it to you? Only to sell to someone else who wants to hoard it. So we have a world sprinkled with bitcoin hoarders, who just have their bitcoins sitting in their laptops, like some dead weight. And they paid $266 for every last one of them. What will be the end of such a situation?

We are not examining something unique in the history of man. It has happened over and over. People paid a lot of money for something that brings them nothing, be it stocks that give no returns, tulips that are way overpriced, gold and silver mines that have no gold or silver. So what did they finally wise up and do? They sold it for a pittance, which was all they could get. Or else they were unable to sell it, and got nothing.

DA: Got you this time, Dave. Gresham’s Law only refers to what happens when there is a fixed legal exchange ratio between two currencies. There is no fixed legal exchange ratio between bitcoins and dollars.

SD: You know that, and I know that, but let’s distinguish carefully between Gresham’s Law and the underlying logic of Gresham’s Law.

DA: What do you mean, underlying logic?

SD: Why will bad money drive out good money? And why only where there is a fixed legal exchange rate? Did the Good Lord decree that it must happen?

DA: Of course not, Dave. The reasoning is simple. If I can force the vendor to take inferior money, and I can keep the superior money, I’ll do it. Thus, the superior money will be hoarded, and he inferior money will be what people spend.

SD: So why does there have to be a legal exchange rate?

DA: That’s just a mechanism for forcing people to take the inferior money when everyone wants the good money. The market rate is, say, 40 ounces of silver for an ounce of gold. But there are laws forcing people to accept an ounce of silver as if it were worth an ounce of gold. Instantly, that makes silver inferior [=overpriced] and also forces the vendors to accept the inferior money.

But once one money is superior and the other inferior, for whatever reason, and there is also a law forcing acceptance of the inferior money, it’s game over. Of course people will stash the good stuff and pass on the bad stuff, since they can force the vendor to accept the bad stuff.

SD: OK, so does bitcoin need some legal fixed exchange rate to be superior to dollars?

DA: Oh, no, Dave. Bitcoins are by their very nature superior to dollars. They are secure, infinitely divisible, cryptographic, money of the future, and the whole world loves them so much more than dollars. Didn’t you ever read the many praises of bitcoin, and why it is so much better than mere old fashioned, outdated, clunky dollars?

SD: Are there legal tender laws forcing someone to accept dollars in the US?

DA: Of course.

SD: So what would you rather keep, a wrinkly grimy clunky dollar, or a brand new shiny, destined to constantly increase in value [due to network effects and kickstarting] bitcoin?

DA: You’re darn right I’m hanging on to my bitcoins. I’m going to pass my dollars on to the next sucker, who is legally obligated to accept them, poor fellow.

SD: Thank you Mr Gresham.

DA: I see what you did there.

[LATER] The redditors came out in droves attacking this article. The most salient point they made, at least to the superficial glance, is that I don’t know what I’m talking about.

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24 thoughts on “Why Gresham’s Law Means the Death of Bitcoin.”

I think the same argument that is used to refute the deflationary spiral also counts in regard to Bitcoin hording.

While I may have a large hoard of Bitcoin that I don’t have any intention of spending anytime soon, that hoard represents my savings. I still spend ~90% of my income on consumer goods. If I find a something I want to buy from a merchant that accepts Bitcoin, I take a portion of my income that Ive allocated to consumption, convert the dollars to Bitcoin and spend the Bitcoin.

It’s true I don’t draw down from my Bitcoin savings to purchase the item, but neither do I hoard the funds I’ve allocated to consumption simply because I’ve converted it to Bitcoin.

Even under deflation people are still going to allocate income to consumption and savings. Consumption spending will still take place. As long as it does, Bitcoin can function as money.

“If I find a something I want to buy from a merchant that accepts Bitcoin, I take a portion of my income that I’ve allocated to consumption, convert the dollars to Bitcoin, and spend the Bitcoin.”

::headdesk::

You’ve proven SD’s point.

Why not just pay in dollars then? If Bitcoins are really “money,” why don’t you use some from your stash? They way you’re describing how you operate is no different than using PayPal, which, after all is the most “moneyish” Bitcoin may ever get.

Bitcoin will be spent in preference to fiat currency if it is advantageous to the holder to do so. When is that? It all depends on a host of factors. There is no theoretical answer. But one thing is certain. It is not all or nothing. So I don’t really see where your point is going. I suspect that the vast majority of holders of Swiss francs “hoard” them rather than spend them, but that does not mean that they thereby lose their character as money.

Gresham’s Law is not in anyway applicable to bitcoins. Greshams law applies to two currencies, one which is over-valued by a government and a second which is under-valued by that same government. Bitcoins are not assigned value by government and hence trying to use Gresham’s law to guess what will happen to them indicates you either-
1. Don’t like bitcoin and are looking for ways to sat its crap, or
2. Don’t understand Greshams law properly.

The proportion is far higher than for almost every other currency.
Proves nothing.
Thus most SF are not used as money to buy stuff in Switzerland.
Non sequitor.

They are hoarded.
Still waiting for some proof. Show me reliable stats about how big the money supply is, and how much of it just sits under someones mattress, unspent.
But that doesn’t stop SF from being money.
True. Bitcoin is not money for other reasons, among them because people use dollars instead of bitcoins to actually buy things. What do people use instead of Swiss Francs in Switzerland? Do they stores price everything in yen or euros or dollars?

You can get a pretty good idea by comparing population with the broad money stock. The ratio for Switzerland is about 3 times higher than for other countries with broadly the same levels of wealth such as Canada and Sweden. One possible explanation is that for some bizarre reason, Swiss people have three times the demand for money holdings that Swedes and Canadians have. But more likely I’d suggest is that the majority of Swiss francs are held as a store of value by non-Swiss people rather than for use as a means of buying stuff using Swiss francs (incidentally the only other place which has a similar ratio is Hong Kong).

I dunno. There are plenty of Zimbabwe dollars around, does it mean there’s some hoarder out there eager for Zimbabwe dollars?
All it tells you is that the govt decided at some point to print that money.

Austrian economics says the amount of money in existence tells you nothing.
What is informative is if there is a change, because it tells you poverty is on the way. But we digress.

I hear you, but will Bitcoin go entirely out of circulation? From what I understand, Bitcoin is designed to bypass the banking cartel. That is, if someone wants to transfer money electronically, one does not need to use a fee based service from a bank or other financial institution to do so.

The fact that it cannot be inflated like fiat currencies makes it a superior money system to the dollar.

A paperbug told me once “you can’t eat gold.” That is true. Paper is inedible too. You can’t add zeros to gold in an attempt to make someone believe it is worth more. Gold is naturally scarce, like Bitcoin. It holds its value and goes up against fiat currencies, like Bitcoin. Gold mostly exists in hoards, like bitcoin. It went from about $250/oz to $1800/oz and back down to $1200/oz. At no time did gold completely disappear. It could always be had for the right price in dollars.

Silver skyrocketed to $40 per oz a year ago. It is under $20 now. It exists in hoards. Yet, in preference to fiat dollars, people will trade those dollars and sock some silver or gold or Bitcoin as savings. I doubt, however, those who have gold and silver and Bitcoin will not trade any of it at any price.

In the early 1980’s the Hunt brothers tried to corner the silver market. Silver went way up in its dollar price. In response, people went into the hoards of coins that they had been saving since the mint replaced the silver coins with debased silver-clad copper and zinc ones and sold them. Silver prices plummeted.

The Federal Reserve is buying $85 billion in bonds every month. Nearly all of those dollars end up sitting on deposit at the Fed. That hoard is over $2.2 trillion dollars now. Dollars, however, are not in danger of being driven out of circulation.

Bitcoin is not tied to any geographic area, like dollars or yen or pounds or euros, if one taxing authority wants to outlaw its use, there are others. In this Bitcoin also resembles gold or silver.

If Bitcoin is mainly being used as a form of savings, it does not mean it will totally disappear because savings are always eventually spent. That is what it is there for – future consumption. Will Bitcoin become worthless in that it will be accepted nowhere in payment or in exchange for other currency? If laws are passed to outlaw its use, maybe. Or, if banks stop charging for the services Bitcoin does for nothing.

Otherwise, trends that can’t continue will eventually stop. I don’t think what is happening with Bitcoin will continue.

Economist Gary North observed that some Bitcoin hoarders are new millionaires in dollars, not in Bitcoin. That is true. And I am a trillionaire in Zimbabwe dollars, not U.S. dollars.

My article Proof Positive that Bitcoin is a Bubble, analyzes the future of bitcoin. I show there that it must go up and up, but for short term scares when someone hacks mtgox or the like. I point out here that it will be hoarded, mostly, during that time. Finally, a time will come when bitcoin will collapse, never to rise up again. I explain the reasons for all these assertions in the Proof Positive article.

All the things you mentioned that are hoarded nowadays, gold, silver, are not used as money, so they are not relevant to a discussion of bitcoins becoming money. As for the fed hoarding money, dollars are the only legal tender and thus have to be used as money in many situations. There is no alternative.

This is why Dogecoin was invented! Dogecoin is just litecoin with a constant high inflation. By greshams law people will spend the Dogecoin and hoard the bitcoin.

But the actual value of the currency is as a transaction mechanism so Dogecoin actually generates more value for the users than bitcoin.

Does this mean that bitcoin woll dissapear? Of course not. Also once a currency starts to lose value, as bitcoin is at the moment, greshams law will save it as people will hoard their paper in the hope of buying more bitcoin with it tomorrow.

1. Dogecoin suffers from inherent inflation, meaning every single day it is worth less and less, and that somehow “generates more value” for whoever has one. Is uranium that loses its radioactivity every second more or less potent as time goes on?

2. People will hoard their paper in the hope of buying more bitcoin, because bitcoin is losing its value. People were hoarding their cash to buy tickets to get aboard the Titanic because it started sinking.

John, if you have a background in the hard sciences, you should have no problem understanding Austrian Economics. So I suggest you begin educating yourself in the basics. Hazlitt’s Economics in One Lesson is free on the internet, and a good place to start.Because I think you have to begin at the beginning before entering into such subtleties as bitcoin.

“One thing the bitcoin enthusiasts have forgotten about is Gresham’s Law. For those who need reminding, it basically states that as long as the dollar is legal tender, meaning you are forced to accept it in payments, then people will spend their dollars and hoard whatever money they perceive as superior.”

No, it says when government sets a fixed ratio between two currencies, the overvalued money will be used instead of the undervalued one. Since there is no fixed ratio, this will not occur. Another swing and a miss from this blog.

Right now, nobody uses gold coins as money, because the laws consider paying in gold as selling your gold, and is therefore subject to sales tax, and if the gold went up in price from when you bought it, to capital gains tax. Gold coins are still valued, just as gold jewelry and gold everything else, because they are gold, not because they are money. Obviously bitcoin does not have this value, because you cannot make jewelry, or anything else, from a bitcoin.

If gold were legal money and there were legal tender laws forcing one to accept paper dollars, then by Gresham’s Law the gold coins would be hoarded. They would disappear from circulation, but1 still be valued because they are gold, and gold is a precious metal that is used for all kinds of things.

What about with bitcoins? The beginning is the exact same thing, and it’s happening right now. People are hoarding bitcoins like crazy. So far it is just like gold, but with this difference. When people hoard those gold coins, they do it because gold coins are valuable right now. When they hoard botcoins, they do it because they are gambling it will be worth a lot more in the future. But why will they be worth a lot more? Because more people will want them? Want them for what use? To hoard, because they will go up in price in the future. [They have no other use.] But a thing valued only because people think it will go up in price is a well recognized object in economics. The technical names for it are “fad”, “mania”, “folly”, and “bubble”.

The paper is right here: http://arxiv-web3.library.cornell.edu/pdf/1410.1231v1.pdf The quotes are from here: http://newsoffice.mit.edu/2014/mit-computer-scientists-can-predict-price-bitcoin Devil’s Advocate: So MIT Guy. I bet you …Continue reading →